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Executive Summary
1. Europe: dismal data, the euro, and currency disruption. Purchasing managers’ index data from Europe show the Eurozone, and particularly Germany, its largest economy, slowing to seven- and ten-year lows. With Europe approaching economic stall speed, downward pressure is mounting on the euro. Several weeks ago, rumors suggested that the U.S. administration was considering currency intervention to weaken the dollar — although economic advisor Larry Kudlow and Treasury Secretary Steve Mnuchin both said that such intervention was not being actively contemplated. We can imagine several future scenarios that might make it a live option for the administration. If the U.S. did intervene, global currency markets would experience severe volatility — and of course, it would be very bullish for gold.
2. China’s National Day. Chinese Vice Premier Liu He secured a delay of new tariffs from the U.S. until October 15 — putting trade war tensions to the side in the run-up to the 70th birthday celebrations of the People’s Republic on October 1. While each ten-year anniversary is typically a big deal, this one is the first to be celebrated under President Xi Jinping — and the Chinese government has been careful to make sure that there’s nothing to overshadow it. That does mean, though, that once the celebrations are successfully concluded, it’s likely that China’s attitude may harden — for example, towards trade negotiations, or towards the Hong Kong protests. We also think that if a big stimulus were in the works for the flagging Chinese economy, it probably would have been launched before the celebration of National Day, and that those hoping for a big stimulus later in the fall will be disappointed.
3. Real estate shifts. Real-estate investment firm Colony Capital, smarting from its troubled 2017 acquisition of NorthStar Realty, is reinventing itself, seeking over the next few years to shed its legacy assets and double down on a shift to digital-related infrastructure and digital real estate management services. Whatever investors think of Colony’s efforts, the trend of higher demand for cloud and wireless infrastructure is likely to be durable as the digitization of the economy continues. A similar trend is the construction of multistory logistics facilities in dense urban areas in the U.S. — a trend that has already emerged in Asia — pushed by consumer demand for same-day and next-day delivery. Real estate investors would be wise to stay abreast of these trends, in our view.
4. Market summary. U.S. markets are entering a typically volatile and unproductive seasonal period, likely to last for several weeks. We continue to remain longer-term bullish on U.S. stocks. We see no signs of imminent deterioration in U.S. credit conditions. On the contrary, the U.S. continues to remain an economic and financial bright spot in the global economy. When the next earnings season gets underway in a few weeks, we will get a clearer view of the effect of global conditions on U.S. earnings. The recent funding stresses that drove U.S. overnight repo rates to spike point out actions that the U.S. Federal Reserve will need to take over the coming year to ensure liquidity. Whether or not they are called “QE,” these purchases — “permanent open market operations,” or POMOs — are the same basic type of action as QE. The liquidity crunch and the Fed’s response highlight that ending extraordinary post-crisis measures may well be more difficult than it was to start them. Still, we do not view current events as an immediate harbinger of financial turmoil. Indian markets responded strongly to Prime Minister Narendra Modi’s dramatic corporate tax cuts. Ultimately, although India will need to adjust fiscal policy moving forward, we continue to believe that Modi is slowly setting the stage for India’s movement towards center stage as a global economy. We view India as a long-term opportunity. Gold will certainly fluctuate with stock market trends and sentiment, but we remain bullish for reasons enumerated in all our recent letters, and regard weakness as a buying opportunity. We believe gold will move higher longer-term, and there are many potential events that could cause it to move significantly higher.
Europe Posts Dismal Data: What Could That Mean for the Dollar?
The Eurozone manufacturers’ PMI, a monthly survey of purchasing managers’ views about current trends in manufacturing, fell to 45.6 in September, down from 47 in August. Anything below 50 is contractionary, and the September reading is the lowest in almost seven years. Germany’s manufacturing PMI fell to 41.4 in September, also going deeper into contraction — the worst reading in a decade.
The message came through loud and clear to global markets — the Eurozone economy is reaching stall speed and probably getting close to recession. These dismal data arrived not long after the European Central Bank cut interest rates further into negative territory and announced plans to begin its asset purchase program again.
The Euro’s Woes Could Lead To Troublesome Dollar Strength
At the same time that Mario Draghi, the outgoing ECB chief, passed the baton of this new, open-ended easing plan to his successor, Christine Lagarde, he called on the Eurozone’s surplus economies — notably Germany — to increase spending and provide a desperately needed fiscal stimulus. Thus far, only the Dutch have taken the hint, announcing a 2020 budget which would use up an additional percentage point of the country’s “fiscal space” (i.e., available budget surplus). Germany, which is running a surplus even as it moves towards recession, will be a tougher sell; it has a traumatic historical memory of the disasters that can follow on runaway spending. Whether the Germans can be persuaded that a little fiscal loosening could save the Eurozone (and all the benefits it has provided them) remains to be seen.
In any event, a diving European economy and further easing from the ECB has global currency implications. Several weeks ago, rumors abounded that the U.S. administration was contemplating moves to intervene in currency markets to weaken the U.S. dollar — though at the time, Treasury Secretary Mnuchin commented, “Situations could change in the future but right now we are not contemplating an intervention.”
What could put such intervention on the table? Sharp declines in the Euro; a failure for the U.S. economy to strengthen from its recent deceleration; or a re-escalation of U.S. trade actions against China — are all scenarios that come to mind.
Such intervention, if it did occur, it would cause significant volatility in global currency markets — on a level not seen for decades.
Of course, currency volatility — and the very prospect of currency volatility — further strengthens the case for gold. While gold can rise because it is functionally a currency that is not subject to central bank manipulation, it can also rise because one of its other roles is as a vote of “no confidence” in the competence of government policy.
Investment implications: Euro area weakness will continue to put pressure on the Euro, and contribute to a stronger dollar. The current U.S. administration has mooted the possibility of intervention in currency markets to weaken the dollar. Eurozone recession is not the only eventuality that might tempt them — U.S. economic weakness in the face of a recalcitrant Fed, or pain from China tariffs finally making it to the U.S., could also put the idea on the administration’s front burner. The consequence would be severe volatility in global currency markets — and a big boost for gold.
What Happens After China’s National Day on October 1?
Every ten years, the People’s Republic of China has a major celebration on October 1, the anniversary of the country’s founding in 1949. This October 1 will be the 70th anniversary — the first major celebration occurring under China’s President For Life, Xi Jinping.
The Chinese government has been taking steps in the leadup to October 1 to ensure that the celebration goes smoothly. This why Vice Premier Liu requested a tariff delay until after October 1 (a request to which President Trump agreed as a “gesture of goodwill”). It’s also probably why China has taken a relatively soft stance towards the Hong Kong protests, not wanting to risk negative global opinion clouding the celebration. And further, as China’s economy slows, the world is waiting to see what kind of stimulus the government may enact to support economic growth. Perhaps some observers think that they’ll get a clearer view of that stimulus after October 1.
The question is what is likely to happen once the celebrations are successfully concluded without being overshadowed by trade wars, economic problems on the mainland, and disorder in Hong Kong.
We believe that after October 1, the Chinese government’s line on some of these concerns and issues is likely to harden, once the celebration has gone well and any potentially embarrassing conflicts are avoided.
That will mean concentrating attention on Hong Kong, where the mainland government believes that unrest is really being driven primarily by the economically precarious situation of the island’s young citizens, and where housing reform is their long-term answer (as well as measures to address income inequality). The government may also act to prevent further capital outflows.
As far as stimulus goes, in our view, if a big stimulus were being contemplated, the government would have enacted it in the leadup to National Day to create positive public and market sentiment. It is likely that no major stimulus is in the works — and that the government remains focused, for the moment, on deleveraging, and is willing to undergo further pain in GDP deceleration. On September 16, Premier Li said in an interview that as long as there are ample jobs, income growth, and environmental improvement, it is acceptable for China’s GDP to be “a bit lower.” (As we noted last week, it is probably closer to 3% than to the ~6% of official statistics.)
And with October 1 successfully passed, and the risk of an embarrassing confrontation over, China may well feel more free to continue to press for a short-term trade compromise that skirts the harder issues of technology and geopolitics. How well that attitude plays will depend in part on political events within the United States.
Investment implications: If China seems to have gotten friendlier in past weeks — a restrained approach to ongoing protests in Hong Kong, offering an interim trade deal with the U.S. — this may just have been to make sure nothing untoward would happen to spoil President Xi’s first major National Day celebration on October 1. On balance, we would look for China’s positions on Hong Kong and domestic stimulus to harden after October 1, with potentially negative consequences for the Hong Kong and mainland Chinese stock markets. As far as trade issues go, it is unclear whether China’s stance will harden or soften.
Real Estate Changes: Colony Goes All-In On Digital, Retailers Build Urban Logistics Centers
Colony Capital [
Prospective stockholders, in the face of the 2017 deal that saw CLNY’s share price drop by some 60%, are likely skeptical and will take a wait-and-see approach.
To us, the announcement is more interesting for its general significance than as an investment case for CLNY (which we are not making). CLNY clearly sees a future runway in real estate assets tied to technology — to cloud growth, the digitization of the economy, continued expansion of wireless technology and data usage, and the application of digital solutions to real estate management itself. Whatever we think of the likelihood that CLNY will successfully reinvent itself, the trend of growth in digital real estate is likely to continue.
A related trend is in logistics. We also read recently that big e-commerce retailers are building multistory warehouses and logistics centers in urban areas — where as one industry executive says, 50-acre spaces are hard to come by. Here also the trend is likely to continue. Amazon [
Investment implications: Real estate markets are shifting. We believe the trends towards demand for data center, wireless infrastructure, and urban rapid-delivery logistics will be durable, and that real estate investors should keep these trends in mind. Please note that principals of Guild Investment Management, Inc. (“Guild”) and/or Guild’s clients may at any time own any of the stocks mentioned in this article, and may sell them at any time. Currently, Guild’s clients own AMZN. In addition, for investment advisory clients of Guild, please check with Guild prior to taking positions in any of the companies mentioned in this article, since Guild may not believe that particular stock is right for the client, either because Guild has already taken a position in that stock for the client or for other reasons.
Market Summary
The U.S.
U.S. markets are entering a typically volatile and unproductive seasonal period, marked in this case by the emergence of new political drama surrounding potential impeachment proceedings against President Donald Trump. Tactical traders may seek to take advantage of seasonal weakness. For our part, we continue to remain longer-term bullish on U.S. stocks. As we have frequently noted, the present market cycle is, like the previous several cycles, fundamentally credit-driven, and we see no signs of imminent deterioration in U.S. credit conditions. On the contrary, the U.S. continues to remain an economic and financial bright spot in the global economy. When the next earnings season gets underway in a few weeks, we will get a clearer view of the effect of global conditions on U.S. earnings.
The recent funding stresses that drove U.S. overnight repo rates to spike point out actions that the U.S. Federal Reserve will need to take over the coming year to ensure liquidity. Accounting for organic growth in liquidity needs, the need to re-establish a larger liquidity buffer, and the rollover of maturing mortgage-backed securities into Treasuries, all imply that over the next year, the Fed will need to purchase a significant quantity of Treasury paper, perhaps $500–$600 billion. Whether or not they are called “QE,” these purchases — “permanent open market operations,” or POMOs — are the same basic type of action as QE. The liquidity crunch and the Fed’s response highlight that ending extraordinary post-crisis measures may well be more difficult than it was to start them. Still, we do not view current events as an immediate harbinger of financial turmoil.
Europe
Some analysts have observed that outgoing ECB chief Mario Draghi’s swan song included a remarkable policy: dual rates, whereby the ECB lends via TLTROs (“targeted longer-term refinancing operations”) at a –0.5% interest rate — but banks get a 0% interest rate on most of their excess reserves parked at the central bank, rather than being penalized. If this analysis is accurate, the ECB is essentially transferring money to banks, and if the process is linked to a requirement that banks extend loans to the private sector, the effect will be magnified. This would be an extraordinary attempt both to bypass the apparently immovable fiscal conservatism of Europe’s surplus economies, and to throw a lifeline to European banks staggering under the effects of negative interest rates. This is quite a baton to pass to his successor, Christine Lagarde, who while she is a consummate politician, has not yet shown herself to be as astute a financier as Draghi. Whether the policy shows genius or desperation (or both), we do not know.
Emerging Markets
Indian markets responded strongly to Prime Minister Narendra Modi’s dramatic corporate tax cuts. Ultimately, although India will need to adjust fiscal policy moving forward, we continue to believe that Modi is slowly setting the stage for India’s movement towards center stage as a global economy. We view India as a long-term opportunity. The same may be true for Brazil, but the changes being put into place by President Jair Bolsonaro are more recent, and to us it is unclear whether they will have staying power. If they do, Brazil could also represent a long-term opportunity.
Gold
Gold will certainly fluctuate with stock market trends and sentiment, but we remain bullish for reasons enumerated in all our recent letters, and regard weakness as a buying opportunity. We believe gold will move higher longer-term, and there are many potential events that could cause it to move significantly higher.
Thanks for listening; we welcome your calls and questions.
Please join us for our quarterly conference call at 1 PM ET / 10 AM PST on September 26, in which we’ll discuss strategies for income investing in a very low interest rate environment, as well as current events and trends and the ongoing bull case for gold.
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Equities Contributor: Guild Investment Management
Source: Equities News
